Markets, Fed Cuts, and the Crowd: What Our Three Tactical Rules are Signaling

Markets, Fed Cuts, and the Crowd: What Our Three Tactical Rules are Signaling

• The Fed’s recent rate cut has turned monetary policy supportive, but inflation and labor market shifts complicate the outlook.
• Equity market trends remain positive, with participation broadening beyond mega-cap tech, though sector concentration is still a risk.
• Investor sentiment has improved but is not euphoric, suggesting a backdrop for continued gains with bouts of volatility.

Rule #1: Don't Fight the Fed- Policy Turning Supportive

The most important recent development for markets was the Federal Reserve’s September decision to cut the federal funds rate by 25 basis points—the first reduction in five meetings. The widely expected rate cut signals the Fed’s concern over a slowing labor market and its willingness to provide support. Other central banks, including the Bank of England and the European Central Bank, have followed with easing measures, creating a globally accommodative backdrop.

Historically, stocks and bonds have tended to perform better in the year following the resumption of rate cuts after a long pause (chart below). Liquidity matters, and the shift to easier policy is a tailwind for risk assets.

Yet the Fed’s job is not easy. Core PCE inflation remains close to 2.9%, well above the 2% target, and tariffs on imported goods could add further price pressures into year-end. On the labor side, payroll growth has slowed dramatically—averaging just 29,000 over the past three months—though demographic changes—driven in part by a decline in immigration—may mean fewer jobs are needed to maintain balance.

Opportunities: Monetary policy is now supportive, historically a positive for equities. Easing also reduces near-term recession risk, as evidenced by the Atlanta Fed’s GDPNow model, which is currently forecasting Q3 GDP growth at 3.3%.
Risks: Inflation is not going away and remains one of the key risks for markets. While rate cuts provide short-term support, they can also boost overall demand and contribute to demand-driven inflation. At the same time, tariffs and limits on labor supply are likely to drive up costs. These factors could restrict how many additional cuts the Fed can make.

Rule #2: Don't Fight the Trend- Markets Still Moving Higher

The second rule focuses on the direction of the market itself. Here, signals remain constructive. The S&P 500 has posted a dozen all-time highs since mid-August, with its 200-day moving average rising at a 13% annualized pace. Importantly, the strength has broadened beyond technology to include consumer discretionary and communication services.

International markets are also participating. The MSCI All Country World ex-U.S. index is trending higher, with the run rate of its primary trend rising at a 24% annualized pace. Global business and investor surveys reflect a cautious but improving outlook, suggesting that the recovery story is not limited to the U.S.

Still, leadership remains uneven. The Russell 2000’s breakout to its first record high since 2021 is encouraging, but other measures of breadth have softened since late summer, reminding us that not all areas of the market are participating equally. Heavy concentration in technology and AI-related stocks is another caution flag (see chart below). With companies like Nvidia carrying very ambitious growth expectations well into 2026, there is risk if results fail to keep up with lofty forecasts.

Opportunities: Positive technical trends are supportive for equities, both in the U.S. and internationally. If breadth improves, it could be further evidence that the broader uptrend is intact and that more areas of the market are starting to participate.

Risks: Heavy reliance on a small group of leaders leaves portfolios more vulnerable if those companies don't meet expectations. In addition, seasonal patterns and the upcoming earnings season could spark short-term volatility.

Rule #3. Beware the Crowd at Extremes- Sentiment Not Yet Overheated

The third rule views investor psychology as a contrary indicator. Excessive pessimism has historically created attractive entry points, while euphoric optimism often signals vulnerability.

Recent sentiment readings across multiple sources tell a consistent story: optimism has improved but not to levels that typically precede large corrections. Ned Davis Research’s "intermediate term" sentiment poll reading sits near the low end of its excessive optimism range (chart below – middle clip), while the short-term version remains neutral (chart below – bottom clip). Other broad measures of investor confidence show modest optimism consistent with average equity gains. Taken together with NDR’s sentiment polls, these perspectives suggest that markets are not yet showing signs of excessive investor optimism.

In practical terms, the environment reflects a market climbing a “wall of worry.” This means that even as markets climb higher, many investors remain cautious and concerned about risks. That ongoing skepticism often acts as support, since it reduces the chance of widespread overconfidence and leaves room for positive surprises to drive further gains.

Opportunities: With sentiment balanced, there is room for equities to continue higher without the risks of broad overconfidence.

Risks: If optimism continues to rise while leadership remains narrow, it could set the stage for sharper corrections down the road.

The Bottom Line

Markets appear set to finish the year on solid footing, supported by a dovish Fed, positive trends, and balanced sentiment. Yet the path will not be straight. Inflation, narrow leadership, and global uncertainties ensure volatility will remain part of the journey.

We will continue to monitor these developments and the message from the market through the lens of these three tactical rules. With the Fed back on the side of investors, trends still supportive, and sentiment not yet extreme, we believe the weight of the evidence favors stocks over bonds and cash. We will continue to monitor our indicators and adjust our allocations accordingly.

Disclaimer: The information contained in this market commentary reflects the opinions of Stratos Investment Management. These opinions do not reflect the views of others and are subject to change without notice. Content in this material is intended for general information purposes only and should not be construed as specific investment advice or recommendations for any individual. Please contact your advisor with any questions or for specific recommendations regarding your own circumstances. Investing involves risks including possible loss of principal. Stratos Private Wealth is a division through which Stratos Wealth Partners, Ltd. markets wealth management services. Investment advisory services offered through Stratos Wealth Partners, Ltd., a registered investment adviser.  Stratos Wealth Partners and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only; and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.  Investing involves risk including possible loss of principal. Some of the information contained herein has been obtained from third party sources which are reasonably believed to be reliable, but we cannot guarantee its accuracy or completeness. The information should not be regarded as a complete analysis of the subjects discussed